Citigroup Finds Obeying the Law Is Too Darn Hard: Jonathan Weil

Nov. 3 (Bloomberg) -- Five times since 2003 the Securities
and Exchange Commission has accused Citigroup Inc.’s main
broker-dealer subsidiary of securities fraud. On each occasion
the company’s SEC settlements have followed a familiar pattern.

Citigroup neither admitted nor denied the SEC’s claims. And
the company consented to the entry of either a court injunction
or an SEC order barring it from committing the same types of
violations again. Those “obey-the-law” directives haven’t
meant much. The SEC keeps accusing Citigroup of breaking the
same laws over and over, without ever attempting to enforce the
prior orders. The SEC’s most recent complaint against Citigroup,
filed last month, is no different.

Enough is enough. Hopefully Jed Rakoff will soon agree.

Rakoff, the U.S. district judge in New York who was
assigned the newest Citigroup case, is saber-rattling again,
threatening to derail the SEC’s latest wrist-slap. The big
question is whether he has the guts to go through with it. Twice
since 2009, Rakoff has put the SEC through the wringer over cozy
corporate settlements, only to give in to the agency later.

That the SEC went easy on Citigroup again is obvious. The
commission last month accused Citigroup of marketing a $1
billion collateralized debt obligation to investors in 2007
without disclosing that its own traders picked many of the
assets for the deal and bet against them. The SEC’s complaint
said Citigroup realized “at least $160 million” in profits on
the CDO, which was linked to subprime mortgages. For this,
Citigroup agreed to pay $285 million, including a $95 million
fine -- a pittance compared with its $3.8 billion of earnings
last quarter.

Looking Deliberate

On top of that, the agency accused Citigroup of acting only
negligently, though the facts in the SEC’s complaint suggested
deliberate misconduct. The SEC named just one individual as a
defendant, a low-level banker who clearly didn’t act alone.
Plus, the SEC’s case covered only one CDO, even though Citigroup
sold many others like it.

Here’s what makes the SEC’s conduct doubly outrageous: The
commission already had two cease-and-desist orders in place
against the same Citigroup unit, barring future violations of
the same section of the securities laws that the company now
stands accused of breaking again. One of those orders came in a
2005 settlement, the other in a 2006 case. The SEC’s complaint
last month didn’t mention either order, as if the entire agency
suffered from amnesia.

The SEC’s latest allegations also could have triggered a
violation of a court injunction that Citigroup agreed to in
2003, as part of a $400 million settlement over allegedly
fraudulent analyst-research reports. Injunctions are more
serious than SEC orders, because violations can lead to
contempt-of-court charges.

The SEC neatly avoided that outcome simply by accusing
Citigroup of violating a different fraud statute. Not that the
SEC ever took the prior injunction seriously. In December 2008,
the SEC for the second time accused Citigroup of breaking the
same section of the law covered by the 2003 injunction, over its
sales of so-called auction-rate securities. Instead of trying to
enforce the existing court order, the SEC got yet another one
barring the same kinds of fraud violations in the future.

It gets worse: Each time the SEC settled those earlier
fraud cases, Citigroup asked the agency for waivers that would
let it go about its business as usual. (This is standard
procedure for big securities firms.) The SEC granted those
requests, saying it did so based on the assumption that
Citigroup would comply with the law as ordered. Then, when the
SEC kept accusing Citigroup of breaking the same laws again, the
agency granted more waivers, never revoking any of the old ones.

Legal Standard

Rakoff seems aware of the problem, judging by the questions
he sent the SEC and Citigroup last week. Noting that the SEC is
seeking a new injunction against future violations by Citigroup,
he asked: “What does the SEC do to maintain compliance?”
Additionally, he asked: “How many contempt proceedings against
large financial entities has the SEC brought in the past decade
as a result of violations of prior consent judgments?” We’ll
see if the SEC finds any. A hearing is set for Nov. 9.

The legal standard Rakoff must apply is whether the
proposed judgment is “fair, reasonable, adequate and in the
public interest.” Among Rakoff’s other questions: “Why should
the court impose a judgment in a case in which the SEC alleges a
serious securities fraud but the defendant neither admits nor
denies wrongdoing?” And this: “How can a securities fraud of
this nature and magnitude be the result simply of negligence?”

A Citigroup spokeswoman, Shannon Bell, said, “Citi has
entered into various settlements with the SEC over the years,
and there is no basis for any assertion that Citi has violated
the terms of any of those settlements.” I guess it depends on
the meaning of the words “settlement” and “violated.”

Rakoff gained fame in 2009 when he rejected an SEC proposal
to fine Bank of America Corp. $33 million for disclosure
violations related to its $29.1 billion purchase of Merrill
Lynch & Co. Rakoff said the settlement punished Bank of America
shareholders for the actions of its executives, none of whom
were named as defendants.

Months later, though, Rakoff approved a $150 million fine
for the same infractions, on the condition that the money would
be redistributed to Bank of America stockholders who supposedly
were harmed. The stipulation was classic window dressing. Even
so, Rakoff became something of a folk hero, simply for daring to
question an SEC settlement. Most other judges are rubber stamps.

Rakoff would serve the public well by rejecting any deal
that leaves the truth of the SEC’s allegations undetermined or
fails to treat Citigroup as a repeated offender. Grandstanding
alone won’t cut it anymore. Rakoff has come a long way already.
Here’s hoping this time he goes the distance.

(Jonathan Weil is a Bloomberg View columnist. The opinions
expressed are his own.)